Economics of southward route are latest blow for Washington

Feb 14, 2004 01:00 AM

by John Helmer

For a decade Washington has been backing the Turkish and Azerbaijani governments to steer the export of Caspian
region crude oil away from Russia. Russia's newest reply has been to ally the Russian and Iranian oil industries, and
open up the shortest, cheapest, and most lucrative oil route of all, southwards out of the Caspian to Iran.
The economics of the southward route are the latest blow for the Bush Administration, as it tries to redraw the
geography of the Caucasus on an anti-Russian map. But for oil exporters and shippers in the Caspian, President George
Bush's jawboning looks to be as futile as King Canute telling the sea to roll backwards.

Early oil from Azerbaijan's newest offshore oilfields has been piped north-westwards through the Russian pipeline
system to Novorossiisk port, on the Black Sea, along with crude from the Caspian shoreline of Kazakhstan. But there
have been frequent arguments with the Azeris over volumes and transit fees, and these have led to frequent oil
stoppages. Azeri oil for transit across Georgia to Supsa port is a costly trickle, by comparison.
In parallel, Turkey has been steadily tightening restrictions on tanker movement out of the Black Sea, through the
Bosporus Straits. The latest rules ban lengthy and large-capacity tankers -- those which are most cost-effective for
charterers and cargo-owners -- from moving through the straits at night. The delay adds to the transport charges,
creating an expensive chokepoint that has multiplied the costs of routing oil through the Black Sea for US allies,
and Russia, alike.

As new Caspian oilfields come onstream, and the volumes of crude lifted grow beyond the capacities of the Russian
pipeline system to absorb, the American strategy has been to press hard to redirect these exports across land towards
Turkey. The pipeline route chosen is known by its origin and destination as Baku-Ceyhan.
The Russian government has always understood that the this pipeline was part of the broader US strategy to cut all
links with Moscow of the former Soviet states in the Caucasus, building new economic infrastructure that would
dissuade the Caucasus group from ever renewing these ties. These efforts have proved to be a colossal boomerang.

A Ukrainian pipeline, designed to attract Caspian oil into Odessa port, on the Black Sea, and then pump it northwards
to Brody, and thence into Poland and other central European destinations, has lain empty for almost a year. Despite
US government prodding, even the major US oil companies in the Caspian cannot quite absorb the commercial
disadvantages of the route. Nor can US allies in the Polish government overrule their colleagues with demands to buy
this anti-Russian, but higher-priced oil.
The Russian government, together the Russian oil exporters, have countered with a proposal for the Ukrainian
government to reverse the oil flow in the pipeline, and pipe Russian crude southwards to Odessa, for tankering out of
the Black Sea.

The conflict in Kiev over thestrategic pros and cons of these alternative oil routes has damaged another US ally in
the region. Late last year, the Ukrainian parliament voted to block the Adria pipeline reversal project. This is
aimed at delivering Russian crude to the deep-water port of Omishalj in Croatia, on the Adriatic Sea. The Ukrainian
veto was retaliation by the anti-Russian oil lobby in Kiev for the failure of its Odessa-Brody project.
The irony of this outcome is that the Omishalj project was first proposed in 2002, and agreed by Russia, Belarus,
Ukraine, Slovakia, Hungary, and Croatia as a way of despatching Russian crude in large tankers to Bush constituents
who own the refineries on the Texas coast of the United States. Initial capacity, according to the Omishalj plan, was
5 mm tpy, rising eventually to 15 mm tons.

The Ukrainian deputies justified their no-vote because, they said, it would be the final blow to the proposed
Odessa-Brody pipeline, should the Druzhba line be filled up west of Ukraine.
"This is true,"says Adam Landes, an oil analyst in Moscow. "but Odessa-Brody is doomed regardless. It offers no
competitive advantage to potential Caspian shippers, or buyers of crude, and this is why it has been idle for two
years now, since it was essentially completed. The longer Ukraine takes to face up to these rather obvious facts, the
longer that this ill-fated pipeline will lie dormant."

Another US ally to be caught in the cross-fire has been Latvia. As the anti-Russian pressure has mounted against
Russian oil shipments in the south, Moscow accelerated the completion of a new oil outlet on the Gulf of Finland and
Baltic Sea. This is Primorsk, which opened two years ago.
Controlled by Transneft, the state pipeline agency, Primorsk receives its crude from the Baltic Pipeline System -- a
network of pipelines linking Russia's new Arctic oil wells and expanding northwest Siberian fields to the sea lanes
to Western Europe's markets. Once the Primorsk outlet was established, the Russian government ordered Transneft to
turn off the supply of oil to Ventspils in Latvia.

At one time the Soviet Union's northern gateway for oil exports, in 1990 Ventspils almost matched Novorossiisk in
capacity and throughput. But no longer. The Latvians have appealed to Washington for help, but Moscow will not
listen. The opening of Primorsk was the deathknell for Ventspils.
The Americans responded in 2003 by pressing the Russian government to end Transneft's monopoly over pipelines, and
allow the Russian oil majors to build a pipeline of their own to Murmansk. That, Washington energy officials claimed,
would open a new, commercially effective route for crude deliveries to US East Coast refineries.

Transneft has responded by accelerating the expansion of the Baltic Pipeline System, while the Kremlin has started
prosecutions of Yukos, the oil company which was closest to Washington. The speed of this pipeline expansion effort
will overtake the growth of Russian export volumes by 2005, Transneft officials have told me. The Murmansk project
will wither, they believe, for lack of oil to ship.
Until Vladimir Putin became president in 2000, Russian oil policy was dictated by a corrupt alliance of the Russian
oil producers and the US government. Putin's campaign against Yukos has put a stop to that. Even during the Yeltsin
period, however, Russian public policy was not to attack the Baku-Ceyhan pipeline on strategic grounds. Rather,
Russian tactics were to play for time, and wait for the economics of oil transportation to tell against the US plan.
So long as crude oil prices remained low, time encouraged delay in starting Baku-Ceyhan. The US war against Iraq
threatened the pipeline plan too, by raising the prospect of a gusher of Iraqi crude on the market, cutting prices.

But now that Bush is proving that he cannot lift Iraqi oil, and prices remain firm for the foreseeable future, a new
counter to Baku-Ceyhan has been needed by Moscow to retain the upper hand.
Russian exporters have responded with a new export route -- southwards through the Caspian to Iran. Russian oil
producers and shippers say they are expecting the volume of crude oil and petroleum products shipped from the Russian
Caspian port of Astrakhan to Iran to more than double this year. A spokesman for Volgotanker, the leading tanker
operator in the Caspian, said it is expecting growth of its oil volume to jump 150 % over the 2003 level of 800,000
tons.

Russian industry sources claim the expansion of the Iranian port of Neka, and the construction of a 120,000-bpd
pipeline from Neka to Rey, is one of the new options for oil movement southwards. The Russian shipments of Caspian
oil are paid for by swap arrangements with Iranian oil shipped out of Persian Gulf ports. Enzeli, the only Iranian
Caspian port able to receive deep-draught vessels, is also being considered for receiving oil aboard railcars shipped
by ferry from Astrakhan.
LUKoil's new oil terminal at Ilyinka, on the Astrakhan shore, will reach transhipment capacity of 3 mm tons annual
capacity (60,000 bpd) next year; this year capacity is 1 mm tons (20,000 bpd).